- Macro data for August point to resumption of gradual slowdown
- President Xi expected to strengthen his position at October CPC summit
- Chinese imports show clear revival after protracted weakness in 2015-16
- Exports have also picked up, but pace of growth is slowing
- Uncertainty from North Korea, but we do not expect major trade war with US
- We upgraded our end-2017 and end-2018 USD-CNY forecasts to 6.60 and 6.75
Economic growth peaked in first half year, gradual slowdown to resume
Last month, we raised our GDP growth forecasts for 2017-18 to 6.8% and 6.5% (from 6.5% and 6.0%). The Chinese economy firmed in late 2016 and early 2017, extending into Q2 of 2017. All this reflects both solid domestic demand (with property markets holding up better than generally expected) and a more dynamic export picture. Although the economy has found a solid footing, we still think a gradual slowdown is likely to resume (the latest macro data seem to be in line with that view). There is less need for the government to add support by for instance raising infrastructure spending. Moreover, there are signs that the real estate market is losing some steam. We also expect targeted tightening measures to provide some headwind. We still do not foresee a sharp collapse, partly because Beijing’s tolerance for instability is low during the coming party leadership shuffle.
Most ‘hard’ August data point to gradual slowdown, but PMIs generally improved
The August data were a bit of a mixed bag. The forward looking PMIs published early this month on balance showed improvement. Import growth also remained strong in August, while car production and sales accelerated. However, the macro data published today are in line with our view that growth will resume a gradual slowdown (compared to the strong first half year). Industrial production growth fell to a 7 month low of 6.0% yoy (July: 6.4%). Retail sales growth dropped to a six-month low of 10.1% (July: 10.4% yoy). Fixed investment slowed to 7.8% yoy ytd, the slowest pace since 1999. Compiling all relevant August data, Bloomberg’s monthly GDP estimate dropped further in August, to 6.9% (from 7.0% in July and 7.7% in June).
CPC Congress will start on 18 October
The 19th National Congress of the Communist Party of China (CPC) will start on 18 October. Key focus of this five-year event will be the CCP’s leadership structure, including the composition of the highest policy committee (Politburo Standing Committee, PSC). Five out of seven PSC members should retire according to ageing rules, with President Xi and Premier Li being the exceptions. We expect the Congress to strengthen Xi’s position as ‘core leader’ of the party, enabling him to appoint allies in the PSC and other top segments of the bureaucracy. Regarding economic policy, we expect more guidance from the Economic Working Conference to be held in December 2017 (when hints to future growth targets are typically made) and the National People’s Congress in March 2018 (when the government reshuffle will be completed and the 2018 growth target will be set).
Cautious, targeted (not aggressive) tightening to continue
Despite the rise in inflation pressures, we still expect the PBoC to keep the benchmark policy rate steady at 4.35% for the foreseeable future, as headline inflation remains clearly below the upper bound target of 3%. Moreover, Beijing’s targeted tightening is not aiming at cutting credit to the real economy, but at combating excessive financial leverage, containing asset (including real estate) bubbles and getting a grip on local government finances. That is why the PBoC has kept the key policy rate unchanged so far (as hiking it would affect corporate borrowing conditions), while guiding money market rates and mortgage interest rates higher. We expect the authorities to continue with targeted tightening. Certainly during the year leadership rotation process, tolerance for instability will be low. Over time reforming and deleveraging SOEs will get more attention.
Reflation still underway
Due to subdued inflation pressures in the first half of this year, we cut our annual average inflation forecasts for 2017-18 last month, to 1.5% and 2% (from 2% and 2.5%). We stuck to our projection that headline inflation would move towards 2% at the end of the year. Recent developments are in line with that view. After having hovered around 1.5% in recent months, CPI inflation rose to 1.8% yoy in August (consensus: 1.6%). The uptick was driven by several food items, causing deflationary pressures from food prices to fade. Meanwhile, after having been stable at 5.5% yoy in recent months, producer price inflation (PPI) bounced back to 6.3% yoy, showing that reflation of the Chinese economy is still underway . The upward move in PPI looks to have been partly driven by the renewed rise in commodity (metal) prices. This bodes well for industrial profit margins and should support heavily indebted industrial companies to manage their debt load gradually down.
After a period of weakness in 2015 and early 2016 …
During 2015 and early 2016 – when the flaring up of hard landing concerns coincided with
a stock market crash and an unexpected yuan devaluation – Chinese import values fell
sharply, by on average 14% yoy in 2015 and 5.5% yoy in 2016. While the drop in imports partly reflected the weakening of domestic demand in this episode, it was remarkable for an economy that was still growing by 6.9% in 2015 and 6.7% in 2016. We should add that the sharp swings in import values are amplified by changes in import prices (as our tentative estimates for import volumes confirm). Moreover, reflecting China’s status as a global manufacturing hub, import values are positively correlated to export values, which have trended downwards in the past years as well.
… Chinese imports have shown a clear revival since the end of last year
This picture has changed. Import values surged in the last two months of 2016 and have remained at relatively high levels in most parts of this year. After having been in negative territory in 2015-16, import growth averaged 18% in January-August 2017 and came in better than expected in August, at 13.3% yoy (July: 11%). This recovery reflects the firming of domestic demand since Q4-2016, supporting emerging Asian economies and the global economy more broadly. Here again we should add that the recovery in import values also reflects the general rise in import prices as well as the pick-up of Chinese exports. Meanwhile, growth of Chinese commodity imports (in volume terms) has been at relatively high levels over the past year or so, but has been coming down in the course of this year. Looking forward, we expect overall import growth to slow further in the coming months, certainly in comparison to the bumper growth reached in in Q1 (+24% yoy).
Export growth has also recovered sharply, but slowed in recent months
Chinese exports have also been weak in past years, reflecting subdued external demand, contracting by an average of 1% yoy in 2015 and 7.5% yoy in 2016. Export growth returned to positive territory this year, despite concerns over trade protectionism. This can not only be attributed to rising export prices and the lagging effects of a more competitive yuan, but also to stronger external demand. The improvement is broad based in terms of export destination, with exports to the US up by an average of 10% yoy so far in 2017 (EU +7%, Japan +5%, Emerging Asia +7%, Brazil +33% and Russia +18%). Still, in overall terms the recovery in exports looks less spectacular than that of imports. In August, export growth fell to a six-month low of 5.5% yoy (July: 7.2%), pointing to the risk that exports may be hit by a stronger yuan (up by more than 6% to USD since late 2016).
Export growth also back in positive territory, but slowing Export revival broad-based in terms of destination
Export values, % yoy Chinese exports by destination, % yoy, 3 month moving average
Tensions in North Korea put China-US relations to the test
Tensions on the Korean peninsula flared up in recent months. Earlier this week, the UN Security Council agreed on a further tightening of sanctions, adopting the eight resolution since North Korea started nuclear tests in 2006. The fresh sanctions are the toughest so far, targeting oil imports, textile exports and remittances from overseas workers. They are also aimed at combating smuggling, ending joint ventures and punishing specific North Korean government institutions. US proposals for even tougher sanctions (e.g. full-stop oil embargo, asset freeze/travel ban on Kim Jong-un and other senior officials) were watered down by China and Russia. Recent comments by US officials including President Trump fed speculation that the US might follow up unilaterally with specific sanctions targeting foreign banks and companies that do business with North Korea. With China being North Korea’s largest trade partner, restrictive trade measures from the US poses the largest risk for Chinese exports going forward. However, we still think that a damaging trade war between the two countries is unlikely, given the wide range of interests that are at stake.
We have changed our USD-CNY forecasts
A lot has changed compared to the turmoil in 2015 and early 2016, when unexpected moves in China’s currency regime unnerved markets and CNY depreciation fears caused capital outflows to rise and Chinese FX reserves to fall. In early 2017, the CNY had fallen to the lowest level versus USD since May 2008. However, the tide has turned completely. Since 3 January 2017, the CNY regained over 6% versus USD, capital outflows have eased and FX reserves have risen for seven months in a row. The CNY’s appreciation to a large extent reflects general dollar weakness, but also relates to a shift in the way the PBoC is managing the currency. The PBoC has stopped following dollar weakness and has even allowed the CNY to strengthen versus its currency basket in recent months.
While all this has helped to convince markets that currency speculation is not a one-way bet, the recent slowdown of export growth shows that there are limits to the extent the PBoC can tolerate CNY appreciation versus USD. It looks like this limit has been hit recently. The PBoC set its reference rate at weaker than expected levels in the last couple of days. This is also illustrated by the recent removal of a reserve requirement on FX forward trading. We expect the CNY to depreciate at a modest pace going forward, reflecting our view that the rate will be set more by market forces. All in all, we have revised our end-2017 and end-2018 USDCNY forecasts to 6.60 and 6.75 (from 6.80 and 6.90), respectively.